Oil: At the peak?

Although IFandP chiefly focuses on the power sector, we also cover the wider trends within the energy space as a whole. With this in mind, it’s worth taking a look at some of the announcements from several of the larger oil companies made over the past few months and at the Davos economic summit together with their wider implications, particularly from the perspective of power utilities.

Perhaps the most startling of these is the news, reported by The Oil Drum, is that the current CEO of Petrobras, José Sergio Gabrielli de Azevedo, has warned that the world will need to bring online the equivalent of one Saudi Arabia every two years to offset future oil decline rates, although he later reduced this to once every three years in a more recent interview with Business Week in January 2010. This is a fundamentally more pessimistic outlook than that of the International Energy Agency that believes that the equivalent of four Saudi Arabias will be needed to be brought online to keep oil production at today’s levels between now and 2030.

Figure 1: World oil capacity and demand to 2030. Source: Petrobras, translation by Luis de Sousa of The Oil Drum.

However, Mr Gabrielli’s comments are in accord with a rising number of similar statements from major oil CEOs, such as Total’s Christophe de Margerie, who has gone record as saying that global oil production won’t ever exceed 89mbpd. Thierry Desmarest, Total’s chairman, said that world oil production could peak in about 10 years, in an interview with the AFP News Agency on the outskirts of the Davos World Economic Forum.

Meanwhile, although BP and Shell have not come out in favour of the peak oil camp, they are still suggesting that a rough time lies ahead in terms of the oil demand/supply balance. Shell’s Peter Voser told his audience at Davos that the oil industry will need to invest a staggering US$27trn over the next 20 years to satisfy demand, while BP’s Tony Hayward believes that output will have to be increased to 100mbpd due to increasing demand from emerging economies.

A sticking point for peak oil’s proponents is the fact that the official stance of Saudi Aramco, Saudi Arabia’s national oil company, is dismissive regarding peak oil supply, choosing instead to worry about oil demand in OECD countries peaking as a result of a shift towards greater use of renewables and the electric car. At the Davos summit, Saudi Aramco’s CEO Khalid al-Falih said that: “The concern about peak oil is behind us,” and that “of the 4trn [barrels] of oil the planet is endowed with, only 1 has been produced. Granted most of what remains is more difficult and complex [to exploit] … there’s no doubt we can do a lot more than the 95, 100[mbpd] that are projected in the next few decades.”

However, while Mr al-Falih’s comments regarding the size of the oil’s remaining oil reserves on paper are correct, they are also misleading when one considers the point from the perspective of oil as an energy source. It is human nature to use the largest and easiest to exploit resources first and therefore, when oil first started being pumped to the surface on a large scale, roughly for one barrel of oil’s worth of effort, 100 hundred more barrels of oil could be produced. This ratio has fallen steeply over the last decades and will fall further as we look to ultra-deep fields and Canada’s oilsands to compensate for the decline in the availability of shallow reservoirs of sweet light crude. This is a major issue for civilisation as a whole, as below a certain level of net energy produced, many activities start to become effectively uneconomical. There is also a real issue that the infrastructure we are dependent on, particularly in the oil and gas sector itself,was built back when the situation was much more favourable, making the issue of the energy needed to maintain the current system, a very pressing one. The situation is somewhat akin to the number of companies that are struggling to cover their pension obligations, which have accumulated as a result of the increase in the average age people reach past retirement. There is also the point that Sadad al-Husseini, the recently retired head of exploration and production for Saudi Aramco, said in an interview back in October 2007, that global oil production has already reached its maximum sustainable plateau and will start to fall within 15 years.

There is also the issue that the size of official oil reserves does not hold up to scrutiny. Back in 1985, Kuwait massively increased the size of its oil reserves on paper, which was thought to be prompted by the decision by OPEC to assign production quotas according to the size of each member country’s reserves. Many other OPEC members followed, including Iran, suggesting that the size of the oil reserve base is substantially inflated. In fact, according to Dr Mamdoubh G Salameh, consultant for the World Bank, back in 2004, a reasonable estimate of OPEC oil reserves would be 516bnbbl, 300bnbbl less than the official figure, based on an average global recovery rate of 29 per cent. This matters, given that Saudi Arabia and Iraq alone are sitting on around half of the world’s untapped reserves.

The UK Industry Taskforce on Peak Oil, lead by Sir Richard Branson, has warned the government that peak oil will mean a crunch that could potentially dwarf the scale of the financial crisis seen in late 2008.

“The next five years will see us face another crunch – the oil crunch. This time, we do have the chance to prepare. The challenge is to use that time well,” Branson will say.

“Our message to government and businesses is clear: act,” he says in a foreword to a new report on the crisis. “Don’t let the oil crunch catch us out in the way that the credit crunch did.”

The Taskforce includes Ian Marchant, CEO of Scottish and Southern Energy group, and Brian Souter, the CEO of transport operator Stagecoach. Chris Skrebowski, the independent oil consultant who prepared a peak oil report for Branson and his colleagues, has indicated that the main factor that has prevented a full-blown energy crisis from occurring already has been the global recession.

“The next major supply constraint, along with spiking oil prices, will not occur until recession-hit demand grows to the point that it removes the current excess oil stocks and the large spare capacity held by Opec. However, once these are removed, possibly as early as 2012-13 and no later than 2014-15, oil prices are likely to spike, imperiling economic growth and causing economic dislocation.” (The Guardian)

Peak oil in practice for the power sector

So what does this all mean for power utilities? To a certain extent, the industry has already learnt its lesson from the 1973 oil crisis. In the aftermath, there was a concerted move away from the use of fuel oil in power generation. Speeding up the ongoing shift towards renewables would be extremely advisable, given that a post-peak situation would drive prices of all fossil fuels up sharply, although the rise of shale gas may help to cushion the blow initially. Perhaps the most dramatic issues for power companies will be the impact on demand. It is logical to assume that the resulting economic downturn will be most severe in those countries that are the largest net importers of energy. This includes the US, Japan and South Korea, as well as many European countries. Concentrating future investment in those countries with as yet untapped oil resources such as Brazil and Iraq could therefore be a shrewd move. China is an interesting case, given its efforts to lock up oil resources in Africa and Latin America. However, it is unlikely that the US would be willing to take this lying down, once the situation becomes apparent. In such a scenario, relations between the two countries will continue to degenerate, making it harder for US companies to gain access to Chinese markets and vice versa.

In general, a peak-aware outlook would also try to maximise the resilience of operations over short-term profitability. Given that high energy prices would lead to a shift away from globalisation, it’s a fair bet to say that the best approach to supply chains will be sourcing locally and with as few links in the chain as possible. This principle extends to investment in renewables. Those that rely on exotic and rare metals and minerals, such as photovoltaics or thin-film technology, will probably lose out to their more robust and simpler counterparts such as concentrating solar power (CSP) or wind power. In terms of conventional power generation, trading a few points of operating efficiency for turbines and generators with cheaper, more easily-replaced components would also be a step in the right direction as would slowly ramping up on-site security. This is specially a concern for transmission and distribution companies, given the high value of scrap copper on today’s markets. In addition, efforts to encourage employees to live more locally could also prove to be a wise move. Given possible opposition from shareholders to any changes that immediately impact on the bottom line, it may well be worth drawing up a peak oil contingency plan to go into effect once the price of fuels and other key input hit an agreed-upon sustained high.

Coal is potentially a false saviour. While BP’s statistical review states that as of 2008, we had 133 years of coal remaining compared to only 42 years of oil, this is at current levels of consumption. Given that this is at current rates of consumption and that the amount of energy contained in these reserves is roughly comparable, coal reserves would dwindle surprisingly quickly under a post-peak scenario, especially as the issue of net energy would also rear its ugly head with alarming speed. However, there is some potential from underground coal gasification, which could significantly boost effective reserves. Another issue is of course that a massive surge in coal use without the use of CCS could backfire dramatically given the impact it would have on global warming and CO₂ emissions. There is also the problem that even under a business-as-usual scenario, it may be hard for coal production and exports to ramp up sufficiently, primarily due to rising domestic demand, with recent examples being China and soon, Vietnam.

The great game

Governments will find themselves with a real dilemma: up the tax burden on power utilities to compensate for spiralling deficits, but create the risk of major blackouts later down the line, or take the fiscal pain in exchange for continued investment. In a post-peak world, the spectre of further military intervention would be a real concern and it would not be surprising if Iraq is just the beginning of a trend, with Iran set to be next on the menu, if the current rumblings are to be taken to their logical conclusion.

From a dispassionate perspective, there are real questions as to whether or not war can ever result in a net gain of energy, particularly given the estimated US$3trn price tag of the second Iraq war. However, even if this is the case, if Mr Gabrielli is correct, then this merely postpones the inevitable for a year or two, such is the rate of oilfield decline and the world’s thirst for oil. A major issue is that the wide-sweeping changes and possible hardships needed to adjust economies to a post-peak world will be extremely difficult for democracies to implement. The US is perhaps the best example, encumbered as it is with a system of checks and balances, which although admirable in intent, creates massive bureaucratic inertia. China is naturally in a much better position, but has problems of its own, such as massive overbuilding, pollution and dramatically rising expectations among its citizens. While the Chinese youth of today appear willing to trade political freedom for prosperity, if their government is unable to uphold its side of the bargain, then civil disorder could be a real issue, particularly when one considers the large excess of single men created by sex-specific abortion, coupled with the one-child policy and the cultural preference for sons.

The major oil-exporters in the Middle East, will be cushioned to some extent from the crisis, but this will hinge on what extent they can diversify their economies from oil, given the reduced purchasing power of their traditional customers. Power utilities in such regions may be able to generate substantial revenue via carbon capture for enhanced oil recovery and as exemplified by the current Masdar city project can and are moving towards greater use of solar power.

The financial crisis seen in 2008 could be a taste of the things to come. One of the major issues of our economy is that the attractiveness of investment hinges on the assumption that the economy is growing as a whole, hence the interest payable on the loan or finance necessary for new projects, is compensated by the fact that its relative value drops as a percentage of the wider economy. This point has been championed by Gail Tverberg, a frequent contributor to The Oil Drum and a speaker at the 2^nd International Biophysical Economics Conference in New York. In a post-peak world, economic growth is either constrained or thrown into reverse, making it harder to justify investment. A related issue is that there is the danger of a oil-constrained global economy suffering from a boom-bust cycle in which every recession drags the price of oil below the point that merits necessary investment in the energy sector, creating a vicious cycle. We will soon know if this is to be our fate, given exceptions of a return to the situation we saw in 2008, by 2012-14.

The stakes couldn’t be higher

Many in the peak oil community often, rather unflatteringly, liken the human race to a culture of bacteria growing in a limited amount of medium. At first there is a lag phase as the bacteria adapt to their new environment, then a log phase in which they grow exponentially, using their resources up at a geometric rate, followed by a plateau as they began to run out of nutrients and start poisoning themselves with their own waste products. Finally, there is then a massive die-back, as the remaining nutrients are not enough to support the large population generated during the exponential growth phase. This metaphor extends to our global population, particularly given that the earth’s carrying capacity for humans in terms of food is artificially boosted by our use of fossil fuels to make fertilisers and engage in intensive agriculture.

As chilling as this scenario is, there is some hope, in that new technologies could free us from our addiction to oil. The recent advances in nuclear fusion are particularly encouraging, but there is a catch. Although commercially-mature nuclear fusion would free us from having to mine and refine uranium and dispose of the resulting waste, the technology is still some years off (potentially up to 50 years away) and even if we had it now, the capital costs and build time for a fusion plant would be roughly comparable to those of today’s nuclear fission reactors. Another issue is that if economies do start to contract, R&D budgets would be slashed, putting fusion indefinitely out of arm’s reach. It is also clear that there are major limits on the extent to which technology can boost oil production. Despite massive financial incentive along with huge subsidies and tax-breaks, the oil industry has not been able to bring crude production in the US or the UK back to pre-peak levels.

To summarise, the actions the power sector needs to make in preparation for a post-peak world are already in progress, primarily being driven by energy security and climate change concerns but the pace of investment may not be able to cope with the speed of the unfolding collapse. To be fair, the concept of peak oil is not one that is universally subscribed to, but politicians and other senior figures are always under substantial pressure to promote confidence in the economy, while the message of peak oil if widely publicised, makes it harder for oil companies to recruit and obtain investment. It should also be remembered that many economists do not include hard biophysical constraints in their thinking and we as human beings have an innate tendency to discount or disbelieve scenarios which we find unpleasant, witness those convinced that climate change is bad science at best and a conspiracy theory at worst. While coming to terms with the coming storm may be hard, history has always rewarded those who took a good, hard look at how things are in reality and acted accordingly, over those who put their heads in the sand.

The original presentation by Mr Gabrielli in Portuguese can be downloaded here, or click this link for a partial English translation and commentary at The Oil Drum.

The latest report from Chris Skrebowski and his colleagues on the case for peak oil and the potential impact it will have on the UK can be downloaded from http://peakoiltaskforce.net/ as of February 10.

An older, but extremely through report by Germany’s EnergyWatch Group on the issue of peak oil can be downloaded here

The original version of this article stated that Mr Gabrielli’s presentation indicated that oil supply was expected to peak this year (2010). It is now understood that this was not the actual intent. Instead it was “put together intending to show a reasonable estimate of the “challenges” that oil supply will face in the long term.” Petrobras’s Press Office, Lucio Pimentel also stated that: “Once again, we do not believe it is possible to predict a peak oil date. In particular, we do not believe it will happen in 2010.”

This does however, smack of an inability to “call a spade a spade”. For example, one could still state that it is extremely “challenging” for the UK to boost its oil production, when in fact the country’s oil output peaked in 1999.